Center Financial Corporation Q2 2008 Earnings Call Transcript

| About: Center Financial (CLFC)

Center Financial Corporation (NASDAQ:CLFC)

Q2 2008 Earnings Call

July 24, 2008 12:00 pm ET

Executives

Angie Yang – Investor Relations

Jae Whan Yoo – Chief Executive Officer

Lonny Robinson – Chief Financial Officer

Jason K. Kim - Chief Credit Officer

Analysts

Brett Rabatin - FTN Midwest

Don Worthington - Howe Barnes Hoefer and Arnett

Julianna Backlicka – KBW

Joe Gladue – B. Riley

Operator

Welcome to the second quarter 2008 Center Financial Corporation earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Angie Yang, with Investor Relations for Center Financial.

Angie Yang

Thank you for joining us today for Center Financial’s 2008 second quarter investor conference call.

Before we begin, please recognize that certain statements that will be made during this call may not be historical facts. They may be deemed, therefore, to be forward-looking statements under the Private Securities Litigation Reform Act of 1995. Many important factors may cause the company's actual results to differ materially from those discussed in or implied by any such forward-looking statements. These risks and uncertainties are described in further detail in the company's filings with the SEC including Center Financial Second Quarter Form 10-Q filed this morning. Center Financial undertakes no obligation to publicly update or revise its forward-looking statements.

As usual, this call will be one hour in duration. Chief Financial’s President and CEO Jae Whan Yoo will begin this morning with introductory comments and a summary of the second quarter results. Chief Financial Officer, Lonny Robinson, will then provide some color and detail on selected highlights. JW will then provide closing remarks before we open up the call for a question and answer session. As usual, Jason Kim, Center's Chief Credit Officer, is also here with us and will participate in the Q&A session.

Now, I'd like to turn the call over to Jae Whan Yoo.

Jae Whan Yoo

Overall, we are very pleased with many positive trends in our second quarter. We believe this result exemplifies the solid progress we are making with our strategic course as we have shared with you over the last year. As you all know well, the current banking environment is vastly different from a year ago. As such, we will focus more of our discussion today on the sequential trends of our results rather than comparing with year-ago results, as we believe this provides a better perspective on Center Financial’s current performance, or you might say our performance in spite of the very challenging banking landscape.

Before Lonny goes over a more detailed discussion of these results, I would like to provide a summary overview of highlights for the second quarter. Over the past year, much of the focus of financial institutions has been on asset quality. I am proud to say that Center continued its record of maintaining healthy asset quality levels. We believe this is a true testament to Center Financial’s historically conservative credit culture and philosophy.

Because losses are inherent in the nature of banking businesses, we do expect to experience some deterioration while we are in the current credit environment, but as you can see from our result, it has been well contained. The consistency with which we have been able to maintain our asset quality underscores Center Financial’s leadership as the safest and soundest financial institution serving the Korean American community in the Southern California market.

Last quarter, we also discussed our focus on strategically managing our balance sheet and prudently lowering costs in light of anticipated declines in business activity, and we have followed through our intentions. During the second quarter, we executed the sale of certain loans to the wholesale market which had the intended impact of lowering our CRE exposure and contributing to a reduction in the percentage of fixed-rate loan in our portfolio. This action also had a positive impact on our capital position which certainly remains well above regulatory guidelines for well-capitalized institutions. Benefiting from a core deposit marketing campaign initiated during the quarter and our aggressive stance on not paying up for competitive CDs and our overall funding strategies, we saw a positive shift in the mix of our deposits, with core deposits up considerable as a percentage of total deposits. In addition, our overall cost of deposits declined significantly when compared with the end of 2008 first quarter, which contributed to a faster than expected recovery in our net interest margin.

As expected, the moderate downsizing of our staff early this quarter as well as other prudent cost-containment measures led to a noticeable reduction in our non-interest expenses. All of these factors contributed to an increase in our earnings as well as improvement in the company’s efficiency ratio, return on average assets, and return on average equity versus the first quarter of 2008.

So again, we are very proud that the strategies that we have put in place have contributed to the positive second quarter results. With that, I’ll pass it on to Lonny to provide a more detailed overview of account behind this story.

Lonny Robinson

Since our release was distributed late yesterday and our Form 10-Q filed early this morning, I’ll just spend some time this morning going over selected items that highlight our overall operating performance for the quarter.

Let’s begin with asset quality. Total nonperforming loans amounted to $8.7 million or $5.9 million net of the SBA guarantee as of June 30, 2008. This is up from $6.7 million, or $4.1 million net of the SBA guaranteed portion at March 31, 2008. The increase to March to June was the result of the following additions: One construction real estate loan in the amount of $2.2 million and three financial loans of $2.3 million. These additions to our nonperforming loans were offset by declines in nonperforming SBA, consumer, and commercial loan categories.

The nonperforming construction real estate loan represents a participation loan that went nonaccrual in the second quarter. A partial charge-off of $201,000 was recorded in the second quarter. After a full evaluation, we found that no additional impairment reserve was necessary as of June 30. The nonperforming trade finance loans represent one loan relationship for which an impairment reserve of $627,000 was recorded at June 30. One of these loans is also guaranteed under the export working capital program to which the SBA provides a 90% guarantee, which equates to $822,000. As JW mentioned, losses are inherent in the business of banking, but the banks that are managed with conservative lending philosophy and stringent underwriting policies will undoubtedly be able to weather the storm.

With nonperforming assets as a percent of total loans of 0.48% at the close of the second quarter, Center Financial remains well poised as having the best asset quality in the Korean American space and is certainly ahead of its current industry averages. As we cautiously and conservatively navigate the adverse credit environment, we continue to adequately provision for loan losses. Reflecting the current expectations for prolonged period of challenging credit condition, we again increased our provision to 1.18% of gross loans, up two basis points from 1.16 as of March 31.

Moving on to loans, we continue to see steady demand for loans, albeit at lower levels than a year ago. However, we are being more selective and cautious than ever, and we are refraining to a greater degree as to the extension of new CRE loans. Center Bank originated $148 million in new loans and renewals during the second quarter, the same level as in the first quarter of 2008. Of total loan production in the quarter, approximately 78% represented variable rate loans, which just 22% being fixed rate and hybrid forms of fixed-rate loans.

As of June 30, 58% of our total loan portfolio was comprised of fixed rate loans. Interestingly, our commercial loans increased by nearly $20 million over March, while all other loan categories reflect reductions underscoring our focus on increasing our CNI loan portfolio, with approximately 69% of our loan portfolio tied to commercial real estate, we are looking at strategic ways in which we can mitigate our exposure to the CRE market. Last quarter, we mentioned the potential of up to $100 million of our CRE portfolio.

During the second quarter of 2008, we sold SBA loans of $25.6 million and $11.1 million in non-SBA real estate loans and posted a gain on sale of loans of $630,000. We also experienced a significant uptick in payoff levels of nearly $40 million over and above what we expected for the quarter. We are also projecting elevated payoffs in the third quarter. Given these factors, we believe we will be able to reach our targeted reduction in our CRE portfolio through an additional sale of approximately $20 million to be completed over the course of the third and fourth quarters of 2008.

As you should all be aware, the market demand for SBA loans has dropped significantly industry wide, and Center Financial is no exception in this regard. During the second quarter, we originated $11 million in new SBA loans, which is down from the $14.4 million originated in the first quarter. Looking forward, we do not see any near term catalyst that would change these current trends.

Given the higher than usual level of payoffs and the strategic sale of loans, our net loan levels as of June 30th declines sequentially by approximately $55 million to $1.82 billion. The reduction this quarter is relatively in line with our management team’s balance sheet strategies for low single-digit growth for 2008.

Now, moving on to deposits and cost of funds, our funding strategies and deposit marketing campaigns resulted in a positive shift in our deposit composition.

Non-interest bearing demand deposits at the end of the second quarter were up by more than $21 million over March. As a percentage of total deposits, GDAs constituted 23% as of June compared with 21% as of March. The money market accounts and NOW deposits at quarter end rose by nearly $38 million over the first quarter, reflecting increases in retail and broker deposits. On the other hand, other deposits in excess of $100,000 as of June 20th declined by approximately $78 million from the end of the first quarter. This reduction represents a strategic runoff of higher cost time deposits which we believe maximized the benefits of our planned sale of loans. Other deposits greater than $100,000 represent 44% of total deposits at June 30th, down significantly from 48% at March 31st.

As we mentioned last quarter, because of the lag time between the rate reductions and the resetting of rates on our deposits, we expected to see continued improvements in our cost of funds over the next couple of quarter, as deposits are re-priced to include the full impact of the rate reductions. On a sequential basis, our cost of funds declined 53 basis points to 2.93%, which is a bit more significant than we originally anticipated. This decline underscores our aggressive stance in pricing competitive deposits. I would like to note that this achievement did not come easy, and I commend our Center Bank team members for working so diligently with the management team to support our overall deposit strategies. With all the higher rates being offered in the market by both the mainstream and the niche banks, we fully recognize that it is quite a challenge to maintain the deposit base.

Now, the significant reduction in our cost of funds helped our net interest margin rebound at a faster pace than we originally anticipated. As a result, we enjoyed a 5-basis point sequential increase in our NIM for the current second quarter, and we expect our NIM to continue to expand throughout the balance of this year as we continue to benefit from the lagging effect of the downward re-pricing deposits, our aggressive management of our cost of funds, and our progressively increasing composition of variable rate loans in our portfolio.

With that, I will turn the call over to JW for some closing remarks.

Jae Whan Yoo

Before moving on to the Q&A session, I would like to reiterate Lonny’s thanks to the Center Bank team members. This is certainly a very challenging operating environment for community banks. Their wholehearted dedication and attentive focus on maintaining strong relationships with our customer base is an essential component of our overall strategies. I thank each and every team member and look forward to working hand in hand with the team for strengthening the safest and soundest focused on Korean-American and other ethnic markets in Southern California market.

With that, let's open up the call to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Brett Rabatin - FTN Midwest.

Brett Rabatin - FTN Midwest

First, on the expense base on the personnel side, that number was lower than I expected. Are your trimming of expenses there done and is that a good run rate going forward, with what you got with one or two new branches here last year?

Lonny Robinson

Yes. The absorption of the two branches and the personnel in that quarterly rate is probably in line, so we’re looking at a quarterly salary and employee benefits of about $5.9 million. I would say that’s probably representative for a run rate.

Brett Rabatin - FTN Midwest

Secondly, on net charge-offs, they were mostly concentrated in what looked to be small CNI credits or in commercial. Was that one credit or was that a bunch of smaller credits in the second quarter?

Lonny Robinson

Brett, one of the things, and we outlined this in our 10-Q, is that we had one larger charge-off which was about $971,000, and it was a commercial loan, and the rest of them were what we’ve typically seen in our portfolio as we’ve reported in the previous quarters. It’s a small business customers. We’ve explained that in the Q.

Brett Rabatin - FTN Midwest

And then, obviously there is an improvement in the total risk-based capital ratio by about 30 basis points. With the sales you’re going to have in the third quarter, are you trying to get to 11% or can you talk about where you want capital ratios to be?

Lonny Robinson

It’s always about a question about our capital. We do believe that by the end of the year our risk-based capital may be very near 11% or may exceed it.

Brett Rabatin - FTN Midwest

Can you talk about underwriting and just the SBA business in general? Did you do any tightening of underwriting standards this quarter for either SBA or the overall loan portfolio?

Jason K. Kim

It seems to be there are a lot of questions about SBA lending activities. As an industry in general, SBA lending demand has declined, and at Center Bank as well, we have seen a decline. We have seen an improvement in SBA delinquency. We were at $4 million at the end of last year of SBA non-accrual. At the end of first quarter, we were at $3.4 million, and the end of second quarter, we reported $2.5 million. That figure is including the SBA guaranteed portion, so we’ve seen an improvement in our portfolio, and most of the SBA delinquency came about from Denver, Colorado. About 5 months ago, we informed you that our LPO manager to stop processing SBA lending until we feel confident in that market place.

Brett Rabatin - FTN Midwest

Can you give some commentary on if you’re seeing any risk migration trends on either the CRE portfolio in general or just the other parts of the portfolio? You don’t have much in construction, and a lot of it I know is not residential, but do you have any thoughts on classified and what not?

Jason K. Kim

Well, from a macro perspective, I think the CRE is located in new developed communities or populated by the subprime mortgage loans. Typically, retail shopping centers, I think, may have some forward-looking issues, but specific type of CREs such as gas stations and car wash CRE loans may have some risk given the soft economy, and we have very small portions in gas stations and cash washes in our portfolio. Car wash portfolio only represents $9 million, gas station is $29 million. The banks should be very selective in their prospective CRE portfolio.

Lonny Robinson

Brett, I’d like to add a couple of things beyond what Jason has said. Overall, our classified assets are down, and our delinquency trends are looking very positive. We were actually pleased with that. I’m not saying that the economy is stabilized or anything like that, but overall we‘re pleased with where we are at today.

Operator

Your next question comes from Don Worthington - Howe Barnes.

Don Worthington - Howe Barnes Hoefer and Arnett

In terms of the expense reduction, you talked in the past a little bit about specific initiatives, but how much of that staff reductions.

Jae Whan Yoo

Actually, compared with the first quarter, we reduced by 14, and we expect more than $1.2 million expense reduction for the 12 months.

Lonny Robinson

Don, when you get a chance to read the 10-Q, in the Executive Summary, we talk quite a bit about the impact of the staff reduction versus the other expense saves. That will give you more color.

Don Worthington - Howe Barnes Hoefer and Arnett

Any update on the legal front in terms of the litigation.

Jae Whan Yoo

Well, Don, I fully appreciate the level of concern on this longstanding litigation case. Since I joined this bank in January last year, resolving the KIC litigation case has been one of my top priorities, and like any legal issues, I’m not able to comment too much detail, but I assure you that we are working very hard to resolve the matter as quickly and efficiently as possible. My personal goal is to affect an economic and reasonable resolution by the end of this year at the latest. Is that a good enough answer to your question?

Don Worthington - Howe Barnes Hoefer and Arnett

What about the First Intercontinental issue?

Jae Whan Yoo

Frankly, we don’t worry that much about that, but we are working on that too very hard, and I think it’s going to be resolved [inaudible].

Lonny Robinson

We actually discussed this in our 10-Q. We’ve updated the disclosure in regards to the litigation there from that standpoint. We’re proceeding through the process. Obviously, we’ve filed our counterclaim, which we disclosed, against them on the claim for the breakup fee, and we’re just moving through the legal process, and as everybody knows, legal processes take time, but we are moving through that process, and so nothing significantly new to report, but we believe as we say in our Q that we have meritorious defenses and actually have a claim against them.

Operator

Your next question comes from Anna Backlicka - KBW.

Julianna Backlicka – KBW

What is the mark that’s currently in your AOCI account? I am looking at your balance sheet, and it looks like there’s an accumulated other comprehensive loss of $1.4 million, and I was wondering what security that’s related to.

Lonny Robinson

It basically relates overall to a client portfolio value over the last couple of quarters. From that standpoint, it is related predominantly to one security, a trust preferred security.

Julianna Backlicka – KBW

Is there any danger that this will become an other contemporary?

Lonny Robinson

Well, we’re monitoring it very closely. We’ve been following it. At this point in time, we don’t believe it’s an OTT issue, but I can’t predict in the future. As the economy continues to deteriorate, I can’t make a prediction on that, but at this point in time, we have determined that it is not an OTTI issue.

Operator

Your next question comes from Brett Rabatin - FTN Midwest. Please proceed.

Brett Rabatin - FTN Midwest

I just wanted to follow on the loan sales that you did on the quarter. Was that $11 million in CRE?

Lonny Robinson

Yes.

Brett Rabatin - FTN Midwest

And you’re expecting $20 million or so this quarter from the CRE portfolio and not SBA, correct?

Lonny Robinson

Right. It’s actually going to occur in the third and fourth quarters, Brett, so we’ll probably do $11 in the third quarter and then probably the balance of it in the fourth quarter.

Brett Rabatin - FTN Midwest

I didn’t see it, but maybe it’s in the queue, but the CRE loans, were they essentially selling for par during the second quarter?

Lonny Robinson

Well, we had a slight profit on those sales. One of the things to keep in mind is we are a relationship bank, and so we retain servicing on these loans as well, but we were able to get a slight premium on them.

Brett Rabatin - FTN Midwest

Is the market still pretty good, and I’m assuming these loan sales are in the hospitality type?

Jason K. Kim

It was a combination, Brett, hospitality as well as multi-use properties.

Brett Rabatin - FTN Midwest

And you have that sector of the CRE portfolio from an exposure perspective close to where you want it?

Jason K. Kim

I think second half will be mostly in the hospitality folio, and just to give you a little color on the premium gains, on the $11 billion sale, we received a premium of $198,000.

Brett Rabatin - FTN Midwest

The prospects for bids for the CRE portfolio, do they still look pretty good? I don’t know who you are selling them to, but I’m guessing that market could tighten up on the second half of the year.

Jason K. Kim

The secondary market, they are tightening up because of their liquidity as well, but we initiated the sale in the beginning of second quarter, so we had a lead to begin with, so I think that played really well for us.

Lonny Robinson

Brett, we expect slight premiums on the sales in the third and fourth quarter as well.

Operator

Your next question comes from Joe Gladue - B. Riley.

Joe Gladue – B. Riley

Just a couple of questions on some of the expense items and what to look for going forward. The legal fees were up a good bit during the quarter. I was wondering if you expect them to stay up there going forward while you work through some of these legal issues, or is this a one-time aberration.

Lonny Robinson

Legal fees continue to be higher than we obviously would like them due to the KIC litigation and now some of the Atlanta litigation. I would expect the legal expenses to probably run in a quarterly date basis about $750,000.

Joe Gladue – B. Riley

Looking a little further down, on this non-interest expense, other expenses were down a good bit sequentially at $375,000 or so. It’s probably in the Q. I haven’t seen it yet, but is there one major thing driving that?

Lonny Robinson

In first quarter, we had some small operating claims that we had paid. It is outlined in the Q in a fair amount of detail, and then we had actually write-down of an OREO property in the first quarter which we sold, here right at the end of the first quarter, so there was a loss of about $68,000 there, and there was some operating loss settlements of about $225,000 that were in the first quarter that we didn’t have in the second quarter.

Operator

There are no further questions.

Angie Yang

Thank you all for participating in Center Financial’s 2008 Second Quarter Conference Call this morning. On behalf of the entire Center Financial team, we appreciate your continued interest and look forward to your ongoing support.

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